Wednesday, January 24, 2007

Ethanol

Sorry for my extended absence from this blog, for various holiday-related, work-related, and personal reasons. But it's good to get back to it.

Bush's SOTU speech last night reminded me of how many interesting economic side-effects a concerted federal ethanol policy would have. But first of all, I suspect that Bush's stated goal of increased ethanol production may be a bit unrealistic. From the text of Bush's speech:

I ask Congress to join me in pursuing a great goal: Let us build on the work we've done and reduce gasoline usage in the United States by 20 percent in the next 10 years.

...To reach this goal, we must increase the supply of alternative fuels, by setting a mandatory fuels standard to require 35 billion gallons of renewable and alternative fuels in 2017.

According to the National Corn Growers' Association (no, I had no idea such a thing existed, either), ethanol production used up 1.43 billion bushels of corn in 2005, out of total US production of 11.8 billion bushels.

Meanwhile, according to this Wall Street Journal article, all of that corn produced about 5.2 billion gallons of ethanol. Yet the US consumes about 140 billion gallons of gasoline per year. To produce 35 billion gallons of ethanol per year would require a seven-fold increase in US ethanol production in just 10 years. So if that ethanol were only made from corn, it would require about 10 billion bushels of corn. (This is the point where you look one paragraph up to remind yourself what total US corn production is.)

Of course, the hope is that it will soon become feasible to start producing ethanol in other ways, but these comparisons do give us some idea of the scope of the problem. And note that all of this would only go toward meeting 20% of the US's projected gasoline consumption in 2017, which means that all of that imagined increase in ethanol production would do little more than account for the growth in forecast gasoline consumption, leaving only a bit left to actually reduce the US's consumption of petroleum for gasoline.

In other words, ethanol from corn seems to hold little hope as a way to reduce US consumption of gasoline. What it does do, however, is essentially put a price floor on corn. As the Wall Street Journal article cited above outlines, the profitability of ethanol production depends crucially on the price of corn (as well as on the price of oil, of course). That means that whenever the price of corn is low, there will be a substantial incentive to turn it into ethanol, increasing the demand for that cheap corn and boosting its price. Hence, the ability to turn corn into ethanol has effectively guaranteed corn farmers a minimum price for their product, something that farmers of almost all crops wish for (or actively lobby for); a price floor is one of the fondest, happiest dreams of most people in the farm business.

In short: it seems like it's not a bad time to be in the business of growing corn. But it also seems like the oil industry doesn't have much to worry about from ethanol.

Contact

The Street Light is written by economist Kash Mansori, who works as an economic consultant (though views expressed here are entirely his own), writes whenever he can in his spare time, and teaches a bit here and there. You can contact him by writing to the gmail account streetlightblog. (More about Kash.)